China semiconductors/SMIC: chip flip

China’s biggest chipmaker Semiconductor Manufacturing International Corporation (SMIC) may not have leading edge technology but it has great timing. Beijing has urged its citizens to buy the local market — which is now at one-year highs. SMIC has targeted Rmb46bn ($6.55bn) for its Shanghai IPO. Not long ago it had hoped to bring in $2.8bn. Its Hong Kong-listed shares jumped 20 per cent Monday. But SMIC’s long-term prospects are not as inviting as the speculative fever suggests.

Markets have put a value on SMIC at nearly $28bn. Beijing needs technological self-sufficiency as the US tightens sanctions on component sales to Chinese companies. Meanwhile SMIC could use the funds to bolster its scale and cut costs. It has boosted its capex outlook to more than $4bn this year.

Yet, more funds will not guarantee SMIC can catch up with rivals. Analysts estimate SMIC to be at least five years behind its global rivals. It still cannot produce the high-end chips that clients such as Huawei need.

Even so, its Hong Kong-listed shares are up more than 310 per cent this year. At 22 times enterprise value to ebitda, they trade at a premium. Rivals such as Samsung Electronics, which makes most of its money from chips, trades at just 4.5 times and TSMC at 11 times.

Demand from Apple keeps TSMC’s sales high while Samsung’s own products support its chips business. Yet SMIC’s biggest client Huawei — about a fifth of its sales — has struggled following US trade sanctions. SMIC also counts US-based Qualcomm and Broadcom as key clients.

The risk of further escalation in tensions between the US and China — and a drop in orders — cannot be ruled out. While revenues from outside China have dropped sharply since 2017, North America still makes up about a quarter of its total revenues. Group top-line fell last year. SMIC also relies heavily on foreign equipment for its production lines.

Massive demand — from retail and institutional investors — for the new Shanghai shares should mean this IPO performs well initially. But once the euphoria wears off, the chipmaker’s structural problems should start showing through. Long-term investors should think twice about paying up.

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